Two weeks ago I gave you an introduction into moving averages and today I am going to give you a practical example of how to use these indicators. The main function of a moving average is to smoothen out price fluctuations. Moving average are trend following indicators, rising moving average show an uptrend and falling moving average show a downtrend. There is a variety of trading strategies based on moving averages. A very popular approach among traders is to use the crossing of a 5 period exponential moving average (EMA) with a 20 period EMA as an entry signal. A popular method – for swing traders – is to apply the crossing of the 50 EMA with the 200 EMA as an entry signal. Other traders use multiple moving averages for their approach the so called “Rainbow”. The below chart is a daily chart of AUD/USD with multiple exponential moving average used by different groups of traders. There are the red and orange EMAs employed by short term oriented traders. The green moving averages used by swing traders who hold their positions over a few days and the blue EMAs. The blue ones are used by traders which hold their positions for many days or even weeks. If prices are below all moving averages you know that all the different groups of traders are currently short the market. In this kind of environment you do not really want to look for long setups if you are a trend follower… It is usually better to go with the flow and look for entry setups for short position in these kind of situations. Especially if you are new to forex trading it is recommended to employ a trend following strategy. Picking tops or bottoms requires a few years of experience and deep pockets. Unless you have both we would recommend a trend following strategy. This means that you would look for retracements within the dominating trend and enter a position in the direction of the major trend. A look at the “rainbow” gives the beginner a very clear picture of the stage a certain currency pair is in at the moment. Join the Forex Competition today and test which trading strategy suits you the best!
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